Alternative Asset Trust Quarterly Report: June 30, 2016

 

The MacNicol Alternative Asset Trust is a multi-strategy, alternative investment platform designed to generate positive and uncorrelated returns against the public stock and bond markets. The Trust, through its underlying limited partnerships, is invested in private real estate and mortgages, private equity, high yield bonds and multi-strategy hedge funds. Combined, the Alternative Trust is invested in more than 150 separate real estate projects, mortgages, hedge funds and private securities. The advantage of combining different alternative asset classes and high yield investments into one Fund include tremendous diversification, enhanced liquidity, and a more predictable and less volatile pattern of returns when compared against the performance of the individual asset classes themselves.

 

 

Chart 1 – Investment Structure MacNicol Alternative Trust

Chart1

 

Alternative Trust Review: The goals of the Alternative Trust are to generate positive “real” returns (after-taxes and inflation) each year, and to generate annualized nominal returns of 6%-8% over rolling five-year periods. We are pleased to report that as of period ending May 31, 2016 the Trust (E Class) has met its primary goals by generating positive returns that have exceeded inflation, while delivering a 5 year return of 11.7% and 10.6% return since inception.

 

Looking ahead, we are anticipating more liquidity from the Trust’s private equity holdings and continued steady results from the Trust’s real estate holdings and hedge funds. During the period, we continue to rebalance the Alternative Trust, reducing its private equity exposure and correspondingly increasing its exposure to real estate. Chart 2 below highlights the asset mix of the Trust as at May 31, 2016.

chat2

 

Highlights

 

Year to date ending May 31, 2016 the Alternative Trust decreased in value by 4.1%. This slight negative performance was a result of a weak US dollar as well as a slight decline in the value of the Trust’s largest public investment (Shopify). Having gone public in early 2015, Shopify is now subject to the day-to-day ups and downs of a public company, and hence we are expecting slightly higher than normal volatility in the Alternative Trust and the Emergence Fund until these shares are ultimately sold in the second half of 2016. To date Georgian Partners has sold off, and distributed to its investors, approximately half its original position in Shopify.

 

 

MacNicol 360 Degree Realty Income Fund

 

The Alternative Asset Trust invests in North American private real estate through its MacNicol 360 Degree Realty Income Fund holdings “360 Fund”. In order to achieve its objectives, the 360 Fund will invest in several value added private real estate strategies focussed in United States and Canada managed by experienced and successful US and Canadian operators and sponsors (“partners”). These partners are chosen for their high degree of local knowledge and experience in deal sourcing, finance, construction, property management, along with an in depth understanding of asset type. Through its partners, the Trust has exposure to more than 120 separate real estate projects and six asset classes across North America. Chart 3 highlights the regions of North America in which our real estate projects are located.

 

The private real estate market in recent years has provided strong returns driven by overall improved fundamentals and increased pricing. However, of late property fundamentals are more divided across asset classes and geographic regions making property type and geographic choices more important.  In addition to our partners facing more competition from institutional investors committing capital directly, more and more of our partners are considering moving away from acquiring the largest assets essentially avoiding the high levels of competition for trophy assets, and instead looking for opportunities that might fly below the radar of other interested buyers. Our overall strategy is to continue to invest alongside partners and their vision of identifying attractive income producing assets with development repositioning and/or operational optionality in the fastest growing regions of Canada and the United States including Texas, Florida, Georgia, Phoenix, Las Vegas and California. Barring dramatic deterioration in fundamentals, or a seismic shift in interest rates, we are of the view private market fundamentals will remain firm across most property types, as evidenced by recent transactions in office, multifamily and industrial markets.  The defensive characteristics of real estate make it all the more attractive in this yield deprived environment.

 

 

360 Fund Second Quarter Highlights: Year to date ending May 31, 2016, the 360 Degree Fund (D Class) declined by 0.6% in USD terms. There were no significant events during the period and all holdings continue to perform as expected with portfolio gains likely as the year progresses. The US economy, in which the majority of the 360 Fund’s investments reside, continues to expand at a modest pace, which in turn is driving real estate valuations and cash flows higher. In addition, inflation in the US remains well contained and mortgage rates remain near record lows. The recent weakness of the US dollar has been a headwind of late but we are of the opinion the CAD dollar may have reached its high and weakness is expected.  Furthermore, with the recent results of the Brexit vote we would expect there will be weakness for commodity currencies, including the CAD.

chart3

 

Commercial Real Estate Outlook (U.S.)

 

Commercial real estate market fundamentals continue to improve across the board in the United States and, with the exception of Alberta, are holding steady in much of Canada. A resilient U.S. economy is leading to healthy tenant demand in all property types. Vacancy rates continued to fall in 2016, and rents are rising in most markets setting up conditions for what we believe will be sustained income growth in the multifamily, industrial, office and, to a lesser extent, retail spaces.

 

Multifamily:  We have a positive outlook for multifamily in Canada and the U.S due to strong demographics, a growing propensity to rent and manageable new supply.    While capitalization rate (“cap rate”) compression improved the valuations of the multifamily space strong fundamentals and demand for product are likely to continue to support the sector and provide for an improved risk reward profile.  The 360 Degree Fund’s multifamily exposure is primarily through its investments in Carroll Funds I, II and III of Atlanta, Georgia. The Carroll Funds invest in Class “A” and Class “B” multifamily complexes in Tier II and Tier II metropolitans in Florida, Texas, Georgia and the Carolinas. With the enhanced focus on value add initiatives and continued potential for margin improvement, the Carroll Funds will continue to make up a healthy weighting in the portfolio going forward.

 

Office: With the recovery in the US office market finally taking hold, the office sector is now at the point in the cycle where expiring contract rents will likely roll up to market,

which, in combination with rent abatements burning down, will put upward pressure on income growth and valuations. Transactions for office properties still account for the largest proportion of the total number of private equity real estate deals since 2015, followed by deals for residential, retail, mixed use and industrial.  This asset class has also continued to command premium valuations on foreign investment and pension fund demand.  We continue to invest alongside partners that will focus on underperforming properties in stable markets, improve property through re-development, capital investments and re-leasing efforts.  The 360 Fund is broadly exposed to the North American office space through its investments in the KingSett Income Fund of Toronto, Rockwood IX Fund of New York, 13th Floor of Florida, and the Ameritus Real Estate Fund of Chicago.

Industrial: The Fund’s exposure to the stable industrial class continues to perform well with rising rents and lower capitalization rates driving returns. As with the office market in the US, income growth is benefiting from the roll up of expiring leases to higher market rents. Though strong market fundamentals have stimulated additional supply in some markets, the current positive upward move in rents are expected to continue at a measured pace in the second half of 2016.  On average, quality industrial product remains in high demand.

 

Retail. Though malls and grocery-anchored shopping centers have demonstrated resilient NOI growth of late, the overall performance of the sector is expected to lag the other property types during the next five years. This under-performance for income growth is primarily due to the longer lease durations inherent for retail tenants (though mall leases allow for percentage rents that allow retail owners to capture higher retail sales growth). However, as long as employment growth remains positive and new supply is limited we expect occupancy levels to continue to improve at a measured pace.  Given our view the environment for landlords is expected to remain competitive we continue to favor necessity based tenants and well located urban portfolios. The 360 Fund has several “value-add” retail investments through its investments with KingSett, Slate Retailand a regional mall in Jacksonville, Fl. which is managed by the Sierra Building Group of Toronto.

The Emergence Fund achieves its objectives by investing in well-respected and managed third-party private equity funds including the Georgian Partners Funds I and II, Northleaf Secondary Private Equity Fund and the Northleaf Private Venture Catalyst Fund. Northleaf is one of the largest and most established private equity firms in Canada

with clients that include the Canadian Pension Plan (CPP) and the Toronto Dominion Bank. The Emergence Fund is also invested in technology growth sectors, most notably software, digital media, healthcare technology and telecommunications, through an investment in a US-based fund (Multiplier Capital Fund I) that specializes in providing convertible debt loans to private companies. This strategy is highly lucrative with less risk than conventional private equity investing because of the senior position of its loans. Multiplier Capital Fund I is currently paying approximately a 15% annual distribution and its underlying portfolio is performing well across the board. Multiplier Capital Fund II is now being organized, applying essentially the same strategy as Multiplier Capital Fund I, to provide secured loans to established and growing businesses backed by venture capitalists and other sponsors in return for an estimated 18-20% target internal rate of return.  Subsequent to the quarter end, the Emergence Fund has expressed interest in Multiplier Capital Fund II as Multiplier Capital Fund I transitions into its harvesting phase.

 

Private Equity – MacNicol Emergence Fund

 

The investment objective of the Emergence Fund is to generate capital gains and income by investing in a portfolio of private equity funds. The Fund seeks opportunities in private equity where capital exit strategies are clearly defined, and are likely to occur within a 5-year time frame. In order to achieve its objectives, the Emergence Fund will invest in several strategies in the United States and Canada managed by experienced and successful partners. These partners are chosen for their high degree of knowledge and experience in deal sourcing, marketing, finance, and execution, and their established network of partnerships.  The Emergence Fund invests in established private equity funds with a focus on companies with defensible franchises, high growth profiles and proven management. Investments will largely focus on profitable companies with high levels of proprietary technology addressing large target markets.

 

The Emergence Fund achieves its objectives by investing in well-respected and managed third-party private equity funds including the Georgian Partners Funds I and II, Northleaf Secondary Private Equity Fund and the Northleaf Private Venture Catalyst Fund. Northleaf is one of the largest and most established private equity firms in Canada

with clients that include the Canadian Pension Plan (CPP) and the Toronto Dominion Bank. The Emergence Fund is also invested in technology growth sectors, most notably software, digital media, healthcare technology and telecommunications, through an investment in a US-based fund (Multiplier Capital Fund I) that specializes in providing convertible debt loans to private companies. This strategy is highly lucrative with less risk than conventional private equity investing because of the senior position of its loans. Multiplier Capital Fund I is currently paying approximately a 15% annual distribution and its underlying portfolio is performing well across the board. Multiplier Capital Fund II is now being organized, applying essentially the same strategy as Multiplier Capital Fund I, to provide secured loans to established and growing businesses backed by venture capitalists and other sponsors in return for an estimated 18-20% target internal rate of return.  Subsequent to the quarter end, the Emergence Fund has expressed interest in Multiplier Capital Fund II as Multiplier Capital Fund I transitions into its harvesting phase.

Liquidity: During the second quarter of 2016, Georgian Partners Fund I sold approximately an additional 30% of its sizable position in Shopify, taking advantage of a rebound in the NASDAQ stock market and a strong first quarter earning’s report from Shopify. As Georgian continues to sell Shopify, it will distribute the proceeds to its investors, including the MacNicol Emergence Fund. To date Georgian has sold off, and distributed to its investors, approximately half its original position in Shopify.

 

Hedge Funds – MacNicol Absolute Return Fund

 

The investment objective of the MacNicol Absolute Return Fund is to generate positive absolute returns under most market and economic conditions with little or no correlation to the US and Canadian stock markets. In order to achieve its objectives, the Absolute Return Fund invests in several value-added strategies managed by experienced and successful Canadian, US and U.K. hedge fund managers. Most of these investments are not available in the public market and are typically not accessible to individuals and

smaller institutions because of high minimum investment thresholds, often in excess of five-million dollars. During the first half of 2016, we added to our investment in the Sankaty European Opportunities Fund (“Sankaty”) which we expect to continue to generate a high-teens net return for its investors. Sankaty (Bain Capital) is one of the largest restructuring and secondary funds in Europe. It seeks to restructure and recapitalize companies and LBO funds (levered buyout funds) that have found themselves with too much debt post the 2009 economic downturn.

 

Closing Comments

 

We continue to be pleased with the progress of the private real estate, private equity, and hedge fund components of the Alternative Trust which continue to perform to our objectives while showing positive growth in both up and down stock markets. With respect to the private equity component of the Trust, we believe we are at an important inflection point for several of our investments which will in turn drive significant positive returns for the Trust in the quarters and years ahead. The 360 Fund continues to reward our investors with improved risk adjusted returns.  We will continue to invest alongside our existing partners that have proven to execute as expected.  The Alternative Trust remains open to new investors and is available for purchase on a monthly basis.

 

Sincerely,

 

MacNicol & Associates Asset Management Inc.